On Thursday, June 28, Qualcomm's (QCOM) CEO Paul Jacobs stated that the company is ready and willing to write big checks to ensure the stability of its supply chain. The company, according to Jacobs, will do whatever is needed to ensure that its chip supply is secure. We believe that while this would be a prudent use of cash, it is not the only thing that Qualcomm should do with its cash. We believe that Qualcomm should return cash to shareholders, and outline the case for doing so below.
A Fortress Balance Sheet: Great, But Unnecessary
Qualcomm, like many technology companies, has a fortress balance sheet flush with cash. As of the second quarter of fiscal 2012 (the company's latest), Qualcomm had $25.529 billion in net cash, which works out to $14.89 per share in net cash (based on 1,714,274,812 outstanding shares). Based on Qualcomm's share price as of this writing, almost 27% of Qualcomm's market capitalization is in cash.
While Qualcomm has been buying back stock and slowly increasing its dividend, we believe that the company should do more to reward shareholders. Qualcomm, in our opinion, does not need to house this much cash, even for a rainy day. In its two most recent quarters, operating cash flow balooned to $3.667 billion, more than double the $1.816 billion it posted in the previous year period. Even when taking out the effects of a income tax benefit, operating cash flow was still over $3 billion in Qualcomm's last 2 quarters quarter, giving Qualcomm the cash it needs to invest in its business.
In the technology industry, companies often hoard cash in order to prepare for a rainy day. Apple (AAPL) is a prime example. The company only recently resumed its dividend payments, which were suspended for well over a decade. And neither that dividend, or its planned buyback, will do much to actually reduce Apple's growing cash pile. Qualcomm is in the same situation. Even a 29.268% jump in R&D spending over the past year has done little to put a dent in the company's cash pile.
We understand the argument for Apple's retention of cash. Given the importance of the iPhone and iPad to Apple's bottom line (to say nothing of the Mac), Apple must always be at the ready to invest billions in the supply chain, at a moment's notice, to ensure that it has access to all the parts it needs. Apple is also investing billions into research and its retail stores, and the trauma of the late 90's, when the company almost went bankrupt is still with Apple. Qualcomm, on the other hand, does not have such a need, in our view. Its status as a fabless chip company, and its patent licensing business model lead to less cash being needed than if the company manufactured its own chips.
Qualcomm's Billions: What Is To Be Done?
Given that Qualcomm has over $25 billion in net cash, how much cash should the company retain? Given the competitive nature of Qualcomm's business, we think that the company should retain at least $10 billion in net cash for a rainy day. And the company should have around $5 billion ready to invest in its supply chain, as CEO Paul Jacobs said it is ready to do. With Qualcomm estimated to earn $3.75 per share in fiscal 2012, and $4.14 in fiscal 2013, we think that Qualcomm can deploy $15 billion to shareholders, and still have the cash it needs to invest in its supply chain, research & development, and save for a rainy day. So what can Qualcomm do with $15 billion? There are two choices available: a special dividend, or a large stock buyback. We analyze the two possibilities below.
(click to enlarge)If Qualcomm were to pay its shareholders a special dividend, each investor would receive a dividend of $8.75 per share, for a one-time yield of 15.71%. That is a huge dividend, and does not even take into account the 1.8% regular dividend yield that Qualcomm has. Qualcomm has been growing its dividend by an average of 14% in the past 5 years, and even with this deployment of cash, we expect that growth rate to hold at or around that level.
There is a bit more analysis needed to quantify the effects of a large share buyback on Qualcomm's earnings per share for fiscal 2012. In its last quarter, Qualcomm grew its share count by 22,856,555 shares, and we will use that figure to calculate year-end shares outstanding. It is important to calculate outstanding shares this way because it captures the effects of stock-based compensation, which will result in new shares, even if Qualcomm buys back stock. Such a method arrives at a share count of 1,759,987,922 shares outstanding (while this is an imprecise method, it is an educated estimate of Qualcomm's fiscal 2012 shares outstanding; the exact number will not be known until after the year has ended). Based on an estimate of $3.75 in EPS for fiscal 2012, Qualcomm is expected to post net income of $6,599,954,708.
Qualcomm has $15 billion with which to buy back stock in this scenario. Let us assume then, that the company will buy back its shares at $60. We chose $60 because it is a conservative figure that accounts for a likely rise in the stock should Qualcomm announce a buyback. We quantify the effects of a buyback below.
| Initial Fiscal 2012 Shares Outstanding | +1,759,987,422 |
| Less Share Buyback ($15 billion @ $60 per Share) | -250,000,000 |
| Ending Fiscal 2012 Shares Outstanding | 1,509,987,422 |
| Old Net Income/EPS | $6,599,954,708/$3.75 |
| New Net Income/EPS | $6,599,954,708/$4.37 |
| Increase in EPS | +$0.62 (+16.533%) |
Under this scenario, Qualcomm can boost its fiscal 2012 earnings by over 16%, and cut its price/earnings ratio from 14.848x fiscal 2012 earnings to just 12.741x earnings. Were Qualcomm to execute this buyback, it could buy back over 14% of itself, and deliver an incremental 16.533% rise in earnings per share, something we see as a positive step.
Conclusions
We have held shares of Qualcomm for some time, and continue to believe that the company will deliver for shareholders. Qualcomm is a part of all the major smartphone ecosystems, and it has consistently demonstrated that it can innovate and maintain its industry leadership position. We believe that Qualcomm's best years are ahead of it, and would be buyers of the company on a pullback. And should Qualcomm deploy capital, something that we think the company should do, we think the shares will rally. Qualcomm is flush with cash, but its business model is such that even a return of $15 billion to shareholders would leave the company in a strong financial position, with all the resources it needs to secure its supply chain, as well as save for a rainy day. In our view, the possibility of a return of capital is just one of the aspects that make Qualcomm a winning investment.
Disclosure: I am long QCOM, AAPL.
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